Employer contributions to a Health Reimbursement Arrangement are taxed favorably on both sides of the transaction: the employer deducts them as an ordinary business expense and owes no payroll tax on them, and the employee receives them free of federal income tax and payroll tax, both when the money is set aside and when it is used to reimburse qualified medical expenses. That double exclusion is the whole point of the arrangement, and it holds only as long as the plan and each reimbursement follow the rules in the tax code.
What the Employer Deducts and Saves
An HRA is funded entirely by the employer. Employees cannot put in their own money, and the arrangement cannot be funded through salary reduction under a cafeteria plan.1Internal Revenue Service. Notice 2002-45 Health Reimbursement Arrangements The company decides the annual contribution.
Those contributions are deductible as ordinary business expenses, reducing the employer’s taxable income dollar for dollar. They are also exempt from the employer’s share of Social Security and Medicare tax, worth roughly 7.65% of every dollar contributed on top of the income tax deduction.2Congressional Research Service. Health Reimbursement Arrangements (HRAs) Federal unemployment tax does not apply either, because federal law excludes payments for medical or hospitalization expenses from the definition of taxable wages.3Office of the Law Revision Counsel. 26 US Code 3306 – Definitions
What the Employee Owes
Nothing, in the ordinary case. The money your employer puts into your HRA never appears on your paycheck and is not part of your gross income. Federal law excludes employer-provided coverage under accident and health plans from an employee’s taxable wages, so there is no federal income tax and no payroll tax on the contribution itself.2Congressional Research Service. Health Reimbursement Arrangements (HRAs)
Reimbursements from the HRA are also tax-free when they go toward qualified medical expenses. The Internal Revenue Code specifically excludes reimbursements paid to an employee for medical care from gross income, provided the expenses meet the code’s definition of medical care.4Office of the Law Revision Counsel. 26 USC 105 – Amounts Received Under Accident and Health Plans HRA dollars stretch further than wages for that reason: you keep the full amount rather than losing a portion to withholding.
The Qualified Expense Condition
The tax-free status of a reimbursement depends on what it pays for. Qualifying expenses are costs for diagnosing, treating, or preventing disease, and they must primarily address a physical or mental health condition rather than general wellness.5Internal Revenue Service. Publication 502 – Medical and Dental Expenses Doctor visit copays, prescription drugs, dental work, vision exams, hearing aids, and inpatient hospital care all count.
Since 2020, over-the-counter medications like ibuprofen, allergy pills, and cold medicine also qualify for tax-free reimbursement without a prescription, as long as the employer’s plan documents allow it. Menstrual care products became eligible under the same change. Both expansions came through the CARES Act and are permanent.
Vitamins taken for general health, gym memberships, and cosmetic procedures do not qualify. IRS Publication 502 covers the most common eligible and ineligible items.5Internal Revenue Service. Publication 502 – Medical and Dental Expenses
When HRA Money Becomes Taxable
Three situations turn HRA dollars into taxable income.
The first is a reimbursement for something that does not meet the IRS definition of a qualified medical expense. The amount gets added to your gross income for the year and taxed like regular wages. This trips people up on borderline items that feel medical but are not, such as teeth whitening or nutritional supplements.
The second is a claim you cannot substantiate. Every HRA reimbursement has to be documented with the recipient’s name, the provider, the date, a description of the service, and the amount. Generic credit card receipts and canceled checks do not describe what was provided and will not support the exclusion. An Explanation of Benefits from your insurer usually does. A claim that cannot be substantiated loses its tax-free status.
The third is a cash-out. When you leave the company, the employer cannot convert your HRA balance into a lump-sum payment. Doing so would cause every HRA distribution you ever received, not just the final balance, to become taxable. The rule exists to keep HRAs from operating as disguised compensation.
The employer carries its own exposure. A plan that fails to satisfy group health plan requirements can trigger an excise tax of $100 per day for each affected employee.6Office of the Law Revision Counsel. 26 US Code 4980D – Failure to Meet Certain Group Health Plan Requirements The IRS has specifically warned that certain non-compliant HRA structures are subject to that excise tax.7Internal Revenue Service. IRS Notice 2015-17 There is also a nondiscrimination rule: if an HRA favors highly compensated employees, those employees lose the income exclusion on some or all of their reimbursements while other workers keep the tax-free treatment.
QSEHRA Rules That Change the Tax Picture
A Qualified Small Employer HRA is for businesses that are not applicable large employers (generally fewer than 50 full-time equivalent employees) and do not offer a group health plan.8Office of the Law Revision Counsel. 26 US Code 9831 – General Exceptions The IRS caps annual contributions. For 2026, the maximum is $6,450 for self-only coverage and $13,100 for family coverage.9Internal Revenue Service. Revenue Procedure 2025-32
QSEHRA reimbursements are only tax-free if the employee carries minimum essential coverage. Without qualifying health insurance, the reimbursements become taxable income. This catches employees who assumed the HRA itself was enough coverage.
Employers report the total QSEHRA benefit each employee was entitled to during the year on Form W-2 in Box 12, using code FF.8Office of the Law Revision Counsel. 26 US Code 9831 – General Exceptions The reporting is informational and does not make the amount taxable by itself.
ICHRA and the Premium Tax Credit
An Individual Coverage HRA lets employers of any size reimburse employees for individual health insurance premiums and other medical costs. There is no federal cap on the contribution.
The tax interaction most employees hit involves the premium tax credit. If your employer offers you an ICHRA that meets the federal affordability standard, you are treated as having an offer of eligible employer-sponsored coverage, which disqualifies you from the premium tax credit on a marketplace plan.10eCFR. 26 CFR 1.36B-2 – Eligibility for Premium Tax Credit That result holds even if you decline the ICHRA. For 2026, an ICHRA counts as affordable if the cost of the lowest-cost silver plan in your area, minus the employer’s ICHRA contribution, does not exceed 9.96% of your household income.
Employees enrolled in Medicare can use ICHRA funds tax-free for Medicare Part A and B premiums, Medicare Advantage premiums, and eligible out-of-pocket costs. Part B alone does not satisfy the minimum essential coverage requirement to participate; you generally need Parts A and B together or Medicare Part C.
HRA and HSA Coordination
A standard HRA usually blocks HSA contributions. To contribute to an HSA, you have to be enrolled in a high-deductible health plan and cannot have other coverage that pays medical expenses before you meet the deductible. A general-purpose HRA is exactly that kind of other coverage, so it disqualifies you.
Employers can structure the HRA around the problem:
- A limited-purpose HRA covers only dental, vision, and preventive care.
- A post-deductible HRA does not reimburse anything until you have met the HDHP’s minimum annual deductible. For 2026, that minimum is $1,700 for self-only coverage or $3,400 for family coverage.11Internal Revenue Service. Revenue Procedure 2025-19
- A suspended HRA lets the employee turn off reimbursements during the period they want to contribute to the HSA, while the balance is preserved.
- A retirement HRA only pays benefits after the employee retires.
If your employer offers both an HRA and an HSA-eligible HDHP, confirm which structure is in place. Getting it wrong can turn your HSA contributions into excess contributions, which carry a 6% penalty for every year the excess sits in the account.